Companies often carry debt on their balance sheets, but the amount of debt only tells part of the story. If a company has, say $20 million in debt but also has $25 million in cash, it can be in a far better financial position that a company with just $5 million in debt but no cash.
For this reason, it is often more useful to look at a metric known as net debt, which is equal to the company's debt if all of its cash and equivalents were used to pay down debt -- or its ability to repay its debts if it wanted to. In other words, net debt is simply the company's total debt minus its cash and equivalents.
It's also important to note that a negative net debt implies that the company has more cash than it owes, which is often regarded as a sign of financial strength and stability. On the other hand, just because a company has a seemingly high net debt level doesn't necessarily mean that it's financially unstable. Net debt is just one piece of the puzzle when evaluating a company's financial state.
To illustrate how net debt can be calculated, let's see if we can calculate Intel's (NASDAQ: INTC) net debt from its balance sheet.
According to Intel's latest balance sheet, the company has $2.6 billion in short-term and current debt, and another $20.0 billion in long-term debt, for total debt of $22.6 billion. However, the company also has $15.3 billion in cash and equivalents. Therefore, Intel's net debt is:
So, while Intel still has a positive amount of net debt, the $22.6 billion in total debt listed on its balance sheet makes the company look more indebted than it actually is.
The bottom line
Keep in mind that debt is just one thing you should look at when evaluating a company. And, also keep in mind that companies take on debt for a variety of reasons. Even so, net debt can help you get a clearer picture of a company's financial stability, so be sure to use it when evaluating potential investments.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!
The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.